1/26/2011 @ 6:00PM

Learning to Love Your Home Loan

Millions of Americans hate their mortgages these days. To many they represent not only their biggest financial liability but also a once promising investment gone sour.

That’s too bad, says Michael Eisenberg, a Los Angeles accountant who finds himself employing the techniques of a Hollywood marriage counselor to dissuade affluent clients from jettisoning their mortgage debt.

“I try to explain that there are advantages to leverage,” Eisenberg says.

Advantages to leverage? Believe it or not, the mortgage is still one of the greatest wealth-building tools available, especially for well-to-do homeowners. Thanks go partly to the laws of economics; leverage in the guise of a mortgage, after all, can amplify gains in a rising market just as it amplified losses in a falling one. Then there’s the Uncle Sam effect. Thanks to federal tax law, no form of debt is potentially as beneficial to the average citizen as the venerable home mortgage.

Here are six ways to make the most out of yours.

CUT YOUR TAXES. Homeowners may know that the interest on up to $1.1 million of mortgage debt is deductible from federal taxes. What many fail to realize is that the math favors the affluent. Suppose that on Jan. 1 your modestly wealthy family took out an $800,000, 30-year mortgage at a fixed interest rate of 5%. Over the first decade of the loan your interest payments will average $36,700 a year. If you’re in the 33% tax bracket, you’ll save about $12,000 annually. So you’re effectively borrowing at a rate under 3.5%.

If a couple filing jointly in the 25% federal income tax bracket borrows $200,000 at 5%, they’ll be able to deduct an average of about $9,100 in annual interest. That’s less than their $11,600 standard federal deduction. Since they can also write off property taxes, they’ll probably get a tax benefit from itemizing deductions, but the aftertax cost of their mortgage will still likely be close to 5%.

BLUNT THE AMT. Moderately wealthy residents of high income tax states are prone to get hit by the alternative minimum tax. If you fit this profile, or are likely to in the future, you can limit your pain by holding a mortgage equal to a large proportion of the value of your home.

Why so? With the AMT, you can’t deduct property or state income taxes. But mortgage interest remains fully deductible. So if you own a lot of house and would pay AMT with or without a big mortgage, it pays to lever up.

PAY EARLY. Debt-averse homeowners know the appeal of shortening the term of their mortgages. Go from 30 to 15 years and your interest rate will fall 0.6 to 0.7 percentage points, says Bankrate.com. There’s also the wholesome allure of retiring your mortgage early.

What’s not to like? First off, refinancing costs can run $3,000 or so. If you swap a 30-year mortgage costing 4.2% annually for a 15-year one at 3.6%, your payments on an $800,000 loan will go up $1,850 a month.

An alternative is to enjoy most of the same benefits by sticking with your 30-year mortgage and prepaying $2,100 a month in principal. You’ll incur no refinancing fees, save enormous interest over the life of the loan and still be able to pay off your mortgage in 15 years. Another advantage: If you run into financial trouble or your kid enters a costly college, you can go back to making regular payments on your 30-year mortgage without becoming delinquent.

OPT FOR AN ADJUSTABLE RATE. These mortgages have gotten a bad rap, thanks to a combination of unscrupulous brokers and incautious borrowers. Don’t be deterred.

If you plan to move in four or five years, why pay to lock in a fixed 30- year rate? You can probably cut your interest rate more than a full percentage point with a mortgage that adjusts in 2016. On an $800,000 home loan that will knock the $3,900 monthly payment down to $3,450. Worried that stagflation will set in by 2016? Squirrel away the $450-a-month savings and by then you’ll have a $27,000 rainy day fund.

PROFIT FROM YOUR EQUITY. If you’ve got equity in your home and a decent credit score, you can take out a $30,000 home equity line of credit for around 5%, Bankrate.com says. As long as you’re not already servicing more than $1 million in mortgage debt, your interest payments on up to $100,000 in equity loans are tax deductible, again bringing your aftertax cost of capital down to about 3.5%. That’s less than Illinois, California, New York and most other states pay to borrow. (Warning: With the AMT you can deduct home equity loan interest only if you use the loan proceeds for home improvements.)

Those who aren’t in the AMT and who are willing to incur some risk can invest a home equity loan in more than 100 companies offering dividend yields of at least 6% and with revenues and stock market values both north of $100 million. They include S&P 500 components like Altria Group and FirstEnergy.

We wouldn’t advise employing this strategy down to your last dime of equity, but it’s not as risky as you may think. Let your home equity sit entirely in your residence and you’re gambling on the value of a single asset. If instead you take out the home equity loan to buy 20 high-dividend stocks, you’ll pocket the interest spread, diversify your risk and potentially enjoy capital gains.

PROTECT YOUR DOWNSIDE. Roughly 11 million homeowners are believed to owe more on mortgages than their homes are worth, with half of them 90 days or more behind on their payments, says CoreLogic. That might strike you as tantamount to financial and moral failure, but seen another way the late payers are taking advantage of the fact that mortgages are noncallable and also usually nonrecourse.

Noncallable means your mortgage banker cannot demand that you repay the remainder of your loan if your home’s value plummets. That’s a distinct advantage over other types of secured debt, like brokerage account margin loans; suffer a drop in the value of your stock or bond collateral and you’ll either have to post more capital or have your collateral seized.

The nonrecourse nature of most mortgages likewise makes defaulting on them less painful than doing so on most other loans. Suppose you buy a $1 million home with $200,000 in cash and take out an $800,000 mortgage. Your timing is lousy and three years later your property is worth only $600,000.

One option would be to walk away from your home and stick your banker with half your loss. Since your mortgage is nonrecourse, the banker will have no rights to your other assets. If you’re really desperate, you could even refuse to move out and live rent-free until your banker manages to evict you. Such moves would, of course, clobber your credit score.